It’s often done with the best of intentions, but manipulating contracts, appraisals, sources of downpayment, and sale prices to help buyers qualify for a higher loan amount – even if it’s suggested by the lender – may make you guilty of loan fraud. Loan fraud occurs when a lender makes an inappropriate loan, because the property is overvalued or the lender has a false picture of the buyer’s financial position. Some experts estimate that as many as one in 10 mortgage loan applications contain some misrepresentation.
Here’s how it can happen: Sally is a good real estate salesperson. She just wants to close the deal and to make everyone happy. But the seller is desperate to sell, and the buyer needs “just a little help on the downpayment.” So Sally writes a contract for $100,000, contingent on a 90 percent conventional loan. Both parties sign it. The contract includes a clause that reads, “Seller to credit Buyer with $1,000 for a drapery allowance.” So far, Sally looks good. She’s written all the terms of the deal – including the payment the seller is making to the buyer – in the contract.
Then the loan officer tells Sally to take the clause discussing the drapery allowance out of the contract and do it as a separate “side” agreement. “If there’s any money being given to the buyer for draperies, it shouldn’t be in the contract because then the loan won’t correspond to secondary market guidelines,” he says. “Just bring me a new contract, and I’ll pretend I never saw the first one.” Sally, who trusts the loan officer, rewrites the contract and gets the parties, who trust Sally, to sign again. The loan officer destroys his copy of the original contract, and the transaction closes with the second contract.
Now the ugly part. The buyer misses a payment. The lender conducts a routine audit and finds out about the “kickback” of funds to the buyer. This payment was part of the transaction but wasn’t disclosed on the HUD-1 statement, says the lender. Next thing Sally knows, the FBI is at her door, pointing out that the incentive payment isn’t in the contract. The buyer and seller say Sally promised that the side agreement was OK. The loan officer swears he never would’ve told Sally to leave it out and that he “never saw a prior contract.” Sally spends thousands in legal fees, loses her real estate license, and barely avoids criminal charges.
If the buyer in the story hadn’t missed a payment, the issue probably never would have come to light. But that doesn’t make it legal or ethical. Nor does it lessen your liability if you’re the one with the bad luck to get caught.
What are some other types of unintentional mortgage fraud that can creep up on even good real estate practitioners like Sally?
- The delayed second mortgage. Since the seller wants to move, he agrees to loan the buyer $10,000 to complete the purchase. The buyer signs a note to the seller to be recorded after closing and receives $10,000 from the seller to use as the downpayment. The purchase contract shows that the buyer bought the property for $100,000 and put $10,000 down. The second mortgage from the seller isn’t mentioned in the contract written by the sales associate.The lender makes what it thinks is a 90 percent loan of $90,000 and receives the $10,000 from the buyer to contribute as the downpayment. Only after the closing does the broker finish the transaction by recording the note as a junior lien on the home.
- The forgiven second mortgage. To help the buyer qualify for a higher loan amount, the seller and the sales associate agree to write a second purchase contract, raising the sale price from $90,000 to $100,000. The buyer gets an $80,000 conventional loan. Both the 80 percent conventional loan and the seller-carried $10,000 second mortgage are included in the contract.The property appraises at $100,000, the buyer puts down $10,000 in cash, and the deal closes. At closing, the seller signs an affidavit that there are no liens on the property other than those stated in the contract. Shortly after the closing, the seller marks the second mortgage paid in full-even though no payments were made-and records a release.
- The owner-occupant investor. An investor wants to qualify for the more favorable mortgage terms available to owner-occupants, so he completes a loan application stating that he will live in one of the units in the building. The broker knows the application isn’t correct but says nothing.
The practitioners in these stories could’ve avoided problems if they’d followed these simple rules.
- Put everything in the contract.
- If the loan officer tells you to “take it out of the contract” or “do that outside the closing,” ask for that direction in writing and keep the document.
- Remember, the loan originator isn’t the final arbiter of what’s acceptable. It’s the lender that finally holds the loan.
- If the parties persist in using illegal loan procedures against your advice, document your advice to your client in writing.
Remember: Your desire to help clients or to get a deal closed could put you on the wrong side of the law and lose you not only a commission, but your license and your reputation.